Trader’s Narrative

Way back at the end of April 2008 I mentioned that I was skeptical about the ability of Canadian fertilizer giant, Potash (POT) to be able to continue the heady pace it had kept for the past few years. I compared the stock rise of Potash to Nortel during the tech bubble and said:

The problem is that right now it is priced for utter perfection. And if the world is one thing, it is imperfect. For one, there is no reasonable logic to its valuation.

I also brought up several key metrics which made the valuation of Potash simply unsustainable. Of course this was only a small part of the much larger commodity bull run which has since, also imploded along with the equity markets. At the start of June 2008, just before oil ramped up to $145, I pointed out that the chart for crude oil had all the markings of a bubble. Now oil is trading at ~$78 a barrel - down 46%.

Nevertheless, when I wrote my thoughts on Potash, I received insulting comments - which always confirms my position. If someone has to rely on emotional outbursts to defend their trade position, there is something obviously wrong. Here is what happened:

The other fertilizer companies which I mentioned have fallen even more than Potash. Agrium (AGU) -55% and Mosaic (MOS) -70%.

Yes, this is about #2. At least the chemical equivalent. So let’s get the jokes out of the way first…

Whenever one stock grows enough to represent an inordinately large percentage of the index it belongs to, you know there is some major dislocation going on. And it is about to be corrected.

Right now that would be Potash (POT) the fertilizer company from Saskatchewan, Canada. Potash is now the 2nd largest company on the Toronto Stock Exchange, at $60 billion capitalization. The largest is RIM (RIMM), which along with Potash has been the engine that has propelled the Canadian indexes higher in 2007 and so far in 2008, almost unassailable.

From the bottom of the bear market in early 2003 to recent times, Potash stock has given the lucky few to have ridden it loyally higher, a “20 bagger”:

The problem is that right now it is priced for utter perfection. And if the world is one thing, it is imperfect. For one, there is no reasonable logic to its valuation. We have more than ample reserves of yet to be mined. In fact, according to the International Fertilizer Association (who should know) at the current rate of use, we have enough proven reserves to last us another 300 years.

And strangely enough, inflation adjusted potash prices have continuously and consistently fallen over time. It is only in 2007 that we’ve seen an exception to this with KCI (potassium chloride) prices tripling. This is a response to a similar rise in the price of sulfur and natural gas (raw materials) for potash.

To bring back some perspective to this, consider a research note from Merrill Lynch saying that if we add the capitalization of the 3 large fertilizer companies: Potash, Mosaic (MOS) and Agrium (AGU) we have a value larger than the sum of the value of all potash ever mined and sold in modern history!

During the tech bubble of 2000 many Canadians remember how the TSX index was pulled higher by Nortel (NT) to levels it wouldn’t have attained by its own accord. But Potash’s (POT) meteoric rise makes Nortel’s look pathetic in comparison.

If you were lucky enough (or smart enough) to buy Nortel at the 1998 October bottom - around $75/share - and repeat the miracle of perfect timing again to sell at the top: August 2000 at around $830/share, you would only be boasting a 10 to 11 “bagger”.

If you have been fortunate enough to be long Potash, the good times may be over. Time again to look for what most are ignoring.